The release this weekend by WikiLeaks of the purported transcript of discussions among International Monetary Fund officials about the best way to compel Greece's creditors to accept debt restructuring led to much finger pointing and seeming indignation.
Yet the economic case for forgiving that country's debt is straightforward: Without relief within a comprehensive reform program, Greece will struggle to grow, unemployment will remain high, and the turmoil will continue to periodically challenge the functioning of the euro zone.
The political calculus is a lot harder, however. Even the window opened by Europe’s refugee crisis is failing to provide a sufficient catalyst for change. If that continues, Greece could end up an element of a much larger threat to the integrity and performance of both the euro zone and the European Union.
Debt forgiveness is never granted easily, and with good reason. Even when it is a financially viable solution, the concept raises fundamental issues of fairness and incentive-compatibility.
Why should a deadbeat debtor be granted relief when others have labored to pay off their debt? What about the creditors who worked hard to earn the money that they lent; why should they be punished? And doesn't the granting of debt forgiveness encourage other debtors to be less diligent, potentially undermining the overall flow of credit that supports economic growth and broader opportunities for well-being and prosperity?
These are legitimate economic questions. Over time, such considerations have rightly made debt forgiveness rare, subject to protracted negotiations or dependent on the outcome of other truly exceptional events. But the economic analysis also suggests that there are a few cases when debt forgiveness is in fact the better option when a "first best" solution isn’t available.
Here is the economic argument:
Beyond a certain point, high indebtedness does more than crush directly the recovery efforts of the debtor. It also inhibits new capital from coming in as fresh providers rightly worry about being contaminated by what is already an excessive existing liability. Without the much-needed oxygen provided by capital inflows, the debtor suffers even more, rendering growth almost impossible and making the debt trap even deeper.
Historical examples include the hard lessons of Latin America's "lost decade" of the 1980s. During this particularly sad episode, many countries struggled to overcome crushing debt burdens and ended up with prolonged economic stagnation, high long-term unemployment and rising poverty levels. The comprehensive debt relief that finally came at the end of the decade and in the early 1990s was too late to avoid misery, especially for the poorest citizens. There also is the example of poor countries in Africa, which benefited from a cooperative global Debt Initiative for Heavily Indebted Poor Countries in the mid-1990s that allowed a notable pickup in their growth, investment and poverty alleviation.
Most economists agree that Greece will not be able to grow without debt forgiveness. It is a necessary, though not sufficient, component of almost any approach to restoring the country to a sustainable growth path, reducing alarming levels of joblessness and avoiding a lost generation of unemployed and disenfranchised youth. Granted in the context of a comprehensive reform effort, such relief also would help restore Greece's status as a full working member of the euro zone, whose objectives extend beyond economics to important social and political achievements.